How to Look at Globalization Now

How should smart companies position themselves in the global economy? By training a historical lens on the process of globalization and thinking about strategies that can take advantage of its current, intermediate state—what HBS professor Pankaj Ghemawat calls "quasiglobalization."

by Martha Lagace

Editor's Note— HBS professor Pankaj Ghemawat, a specialist in strategy and the dynamics of globalization, says that while market integration has made deep inroads in the last few decades, according to the evidence, it's still far short of what economic theory would call perfect integration. In this email interview with HBS Working Knowledge's Martha Lagace, he discusses what companies should bear in mind going forward.

Lagace: People often equate globalization with the idea that globally standardized products are displacing local ones. In one of your new working papers, "Global vs. Local Products: A Case Study and a Model," you tackle this widely held belief. Is it borne out by reality? What surprised you about the experience of STAR TV in Asia?

Ghemawat: It is widely believed that globally standardized product varieties are displacing locally customized ones in many product categories. But there is actually no systematic evidence on this subject.

Given that dearth of evidence, I adopted the research strategy of picking an interesting sector and zooming in on a particularly interesting case within it, and then generalizing back from the specifics of the case study through a simple theoretical model that looks beyond its idiosyncratic elements.

The case concerns STAR TV, which was founded in 1991 by Li Ka-Shing and his Hong Kong-based Hutchison Whampoa group as an English-language broadcaster of mainly Western fare that targeted the top five percent of Asia's socioeconomic pyramid. But by the end of its first decade of operation, STAR had metamorphosed into a series of local [national] businesses, largely independent from each other, offering thirty channels of programming in eight languages.

STAR's evolution indicates, first of all, the abiding preference—demonstrated in all regions around the world—for local TV programming, even if it costs much more than imported programming. The decreasing viability of the standardized model also suggests, and theoretical modeling confirms, that many of the dynamics that often accompany globalization can in fact increase the viability of locally standardized strategies over time. Specifically, dgrowth, the broadening of demand beyond the elite to the masses, and reductions in fixed costs/scale sensitivity on the supply side, are all capable of reducing the equilibrium level of global standardization, as is the ability of local producers to pre-commit costs to particular markets.

Convergence of the price of the globally standardized product across countries also has similar effects. Overall, the analysis suggests that the global standardization hypothesis has considerably less momentum than the juggernaut that it is sometimes portrayed as.

Q: You have written that customer preferences for globally standardized products are neither necessary nor sufficient for such products to displace locally customized varieties. What factors do seem to matter?

A: In some products, unlike most categories of TV programming, willingness-to-pay may actually be higher for globally or regionally standardized products than for locally customized ones. But what really matters for relative viability, even if one focuses just on prices, is the pass-through of a higher price realization to the global producer after typically higher transportation and distribution costs, tariffs, or even risks, are netted out.

Empirical evidence from the international trade literature indicates that the extra costs (not directly borne by the global producer) and risks of cross-border operation continue to be very significant. As a result, the net price premia, adjusted for risk, available to producers of globally standardized products over locally customized ones seem smaller, in general, than the premia that might be paid by end-users.

Second, of course, looking at prices alone is insufficient to look at the relative viability of globally standardized vs. locally customized products. It's obvious that we need to look at costs as well—which, I should add, are often higher for globally standardized products. Yet the bulk of the related literature, which focuses on whether consumers prefer global brands, misses out on supply-side considerations related to costs.

Q: How can the study of strategy and competition contribute to an academic arena that has been mostly examined by international marketing? What kinds of analysis would you like to see so we can gain a fuller understanding of globalization?

A: I see three kinds of contributions as forthcoming. First, taking a cross-functional or strategic approach to globalization is often essential to a proper conceptual framing of the issues, as in the preceding illustration of the need to integrate supply-side and demand-side perspectives in assessing the relative viability of globally standardized and locally customized business models.

Second, I think strategists—and others—can and should supplement the existing empirical evidence related to globalization, which is surprisingly scanty on many important issues.

While many traditional forms of arbitrage may look dated, new ones with more contemporary accents have emerged.— Pankaj Ghemawat

Consider, for instance, the basic belief that globalization is increasing industry concentration—a belief that bridges both sides of the divide about whether globalization is good or bad. However, data on more than a dozen global/globalizing industries that Fariborz Ghadar of Penn State and I have assembled and analyzed indicate that in many of these industries, global concentration hit post-war highs in the 1950s but then declined rapidly in ways that overshadow relative stability more recently.

Thus, in automobiles, for example, there has been a steady decline in concentration since 1955 as the U.S. share of total demand has fallen, and as the declines in General Motors' global share have been dispersed across an increasing number of competitors—deconcentrating effects that the recent wave of mergers and acquisitions has barely begun to reverse. Yet more than one large automaker seems to have engaged in major acquisitions precisely because of the mistaken belief that concentration is increasing rapidly in its industry. Our article, "The Dubious Logic of Global Megamergers," in the July-August 2000 issue of Harvard Business Review, provides additional details on concentration patterns in autos and some of the other industries that we have studied.

Q: In another of your working papers, "Globalization as Market Integration and the Future of International Business," you mention that horizontal multinational enterprises that engage in replication are often perceived as true multinationals. What problems do you see with this perception?

A: There is a powerful distinction to be drawn between two potentially profitable cross-border functions that firms can perform: arbitrage, which involves capitalizing on differences or distance between countries, and replication, which involves capitalizing on similarities or proximity between them. While firms often build bridges across borders in more than one of these ways at a time, it is often possible—and useful—to specify the cross-border function that is, in economic terms, central over long periods to their strategies for adding value by competing around the world.

Viewed in these terms, probably the single most remarkable thing about the historical narrative is the length of time for which firms' international economic activities were apparently motivated entirely by considerations of arbitrage, with no replication in sight. The great trading companies arbitraged across extreme differences, due to essentially geographic factors, in absolute costs/availability: Spices, to take just one example, could be grown in the East Indies but not in Northern Europe.

The same was essentially true of the global whaling fleets of the late 18th century, and the vertically integrated agricultural and extractive (mining) companies that emerged relatively early in the 19th century. The free standing enterprises that dominated British foreign direct investment at the end of the 19th century attempted to arbitrage across differences in administrative structure (and power) by pursuing foreign investment opportunities under British law. Exports of labor-intensive, capital-light manufactures by countries with relatively low labor costs—e.g., textiles and garments—involved arbitrage as well, but across economic differences rather than geographic or administrative ones. (See my article, "Distance Still Matters" in the September 2001 issue of Harvard Business Review for discussion of different dimensions of distance that matter for cross-border activity.)

In contrast, replication emerged as a significant component of international economic activity only towards the end of the 19th century but, by the end of the 20th century, had apparently grown to account for the bulk of it. Partly for this reason, replication is often treated, at least implicitly, as what "modern" or "true" multinationals do. Another part of the reason may be related to the sneaking sense that the activities underlying traditional forms of arbitrage—hunting, fishing, farming, digging, and weaving in the cases cited in the previous paragraph—were, to be blunt, backward.

But while many traditional forms of arbitrage may look dated, new ones with more contemporary accents have emerged. Some (relatively rich) emerging countries now exploit the economic advantage of relatively low labor costs to move quickly into the manufacture of high-tech products, such as wireless phones, microprocessors, personal computers, and even computer networking gear—to the point where the original proponent of product life cycle theory, the late Raymond Vernon, disavowed it on the grounds that developing countries no longer remained focused on old, low-tech products.

Traditional trading companies may have declined along with the margins on the products that they carried, but new types of marketmakers have come to the fore. Current counterparts to the free-standing enterprises of the early 20th century in the performance of administrative arbitrage can be found in national capital that camouflages itself as foreign capital to secure better legal protection or otherwise favorable treatment (e.g., "recycled" FDI into—and out of—China and India).

And to touch on the final base of the CAGE framework for assessing distance that was introduced in "Distance Still Matters," even cultural distances are being exploited to boost cross-border economic activity. Thus, the "deterritorialization" of culture and its stretching out in geographic space has numerous opportunities for cross-border marketing to diaspora or expatriate communities, especially now that they are better connected to their homelands.

For these reasons, it would be a great mistake to conclude that the new function of replication has somehow supplanted the old function of arbitrage. Arbitrage and replication are distinct functions, and their cross-border potential varies from context to context. And more broadly, arbitrage is just one of the alternatives to replication as far as adding value by operating across borders is concerned; others can be identified as well.

Q: Globalists and global skeptics have had plenty to argue about in recent years: as you write in the same paper, globalists gained confidence from the fall of the Berlin Wall, but the Asian financial crisis and instability in Latin America and Russia give fodder to the global skeptics. Why do you advocate a more historically measured view of globalization?

A: Accounts of the cross-border integration of markets have tended to get very wrapped up in the times in which they were written—perhaps too much so. Thus, political scientist Karl Deutsch and associates, relying on research conducted in the early 1950s, emphasized that the internationalization of transactions had declined significantly since the beginning of the 20th century, and averred that this trend was unlikely to be reversed any time soon.

Contrary to their predictions, cross-border economic activity surged in the postwar period and, as it breached prewar records, inspired forked responses, with optimists stressing that international economic integration had reached new heights while pessimists insisted that it had barely returned to levels experienced nearly a century earlier. Optimism about globalization drew strength from the fall of the Berlin Wall in the late 1980s and the rapid growth in much of Asia through much of the 1990s. But then came the Asian financial crisis, Russian instability and a perceived "globalization backlash," to the point where it is probably fair to characterize the prevalent mood, among practitioners at least, as one of pessimism rather than optimism about globalization.

The evidence reviewed in the paper that you cite suggests that it might be preferable to take a more measured, historically self-conscious perspective on cross-border integration instead of announcing changes in its direction or speed with high frequency. Specifically, the empirical evidence indicates that most measures of market integration have scaled new heights in the last few decades but still fall far short of economic theory's ideal of perfect integration—an intermediate outcome that I refer to as quasiglobalization.

Looking forward, levels of cross-border integration may increase, stagnate, or even suffer a sharp reversal if the experience between and during the two World Wars is any indication of the possibilities. But given the parameters of the current situation, it seems unlikely that increases will any time soon yield a state in which the differences among countries can be ignored—multinationals' best efforts to connect markets across borders notwithstanding. Or that decreases could lead to a state in which cross-border linkages can be forgotten about.

So one does not have to make a precise forecast to diagnose that quasiglobalization as a condition is sufficiently broad to persist for some time to come. Achieving similar stability in attitudes toward cross-border operations would seem preferable to manic-depressive swings in attitudes about the outlook, if only for purely pragmatic reasons.

Q: What research projects will you be working on next?

A: I have about a dozen papers and cases related to globalization under way right now, so maybe we can talk about the next crop in a year or two—and about a book that I am starting to work on over a slightly longer time frame.

In the meantime, let me cite just one strand of work that may be of particular interest to both academics and practitioners who read HBS Working Knowledge. The diagnosis of quasiglobalization does more than just supply a relatively stable frame of reference for thinking about the environment of cross-border operations. Note that it substantially enriches the strategy space available to firms that compete across borders relative to the extreme cases of complete isolation of country markets (under which localization would be the obvious strategy) and of complete integration (under which global standardization, in the sense of selling the same product everywhere in the same way, would be favored). Identifying and discussing the implementation of mid-range strategies, aimed at exploiting conditions of quasiglobalization, would seem to be a high priority and is one of the topics on which I am currently doing some work.